The finance ministers and central bank governors of the world gathered this weekend in Washington for the annual meeting of countries that are shareholders in the International Monetary Fund.  As financial turmoil continues unabated around the world and with the IMF’s newly lowered growth forecasts to concentrate the mind, perhaps this is a good time for the Fund – or someone – to save the world.

There are three problems with this way of thinking.  The world does not really need saving, at least in a short-term macroeconomic sense.  If the problems do escalate, the IMF does not have enough money to make a difference.  And the big dangers are primarily European — the European Union and key eurozone members have to work out some difficult political issues and their delays are hurting the global economy.  But, as this weekend’s discussions illustrate, there is very little that anyone can do to push them in the right direction.

The world’s economy is slowing down, without a doubt.  The latest quantification was provided Tuesday of last week in the IMF’s World Economic Outlook, which is perhaps the most comprehensive forecast of global growth and its main components (see Table 1.1).  (Disclosure: I helped produce and present this view was I was chief economist at the IMF, but I left that position in summer 2008.)

The IMF has reduced its forecasts for both 2011 and 2012, but the latter is a more notable change (we can already see the gloomy 2011 picture all around us).  Compared with its view in June, the IMF expects global growth in 2012 to be 0.5 percentage points lower (than previously expected).  Part of the pessimism is for the United States – total GDP growth in 2012 is only expected to be 1.8 percent; anemic at best.  (Remember that our population typically grows at just under 1 percent per annum, so this level of growth would barely put a dent in unemployment.)

But the really stark message is for Europe.  According to the IMF, the eurozone as a whole will expand at only 1.1 percent in 2012 and hopes that troubled countries will grow out their debts seem increasingly like a stretch.  Just to take one example, Italy’s forecast for 2012 has been marked down to just 0.3 percent – and even in the best case scenario, credit availability there seems likely to get tighter over the coming months, which may further slow growth.

A potential recession in the eurozone and a weak recovery in the United States does not make for a world crisis.  Beware people who demand that the world be saved – usually they are making the case for a bailout of some kind.

Don’t get me wrong — a serious crisis could still develop.  There are plenty of warning signs regarding the situation in Greece and its potentially broader impact.  According to the IMF’s Fiscal Monitor, also released last week (see p.79) Greece’s general gross government debt is now forecast to rise to nearly 190 percent of GDP in 2012, before falling back towards 160 percent by the end of 2016.  At this point, Greece needs a global growth miracle – and there is no sign of this on the horizon.

If Greece pays less on its debt than currently expected, this will push down the market value of other sovereign debts in Europe.  As The Economist argued recently, the government debt of some large eurozone countries has unambiguously moved from the category of “risk-free” to “risky” in the minds of investors.

The numbers involved are big.  Italy, for example, had public debt over 1.84 trillion euros at the end of 2010 (using the latest available Eurostat data, “general government gross debt,” annual series).  The GDP of Germany is around 2.5 trillion euros and there is no way that German taxpayers would be comfortable in any way guaranteeing a substantial part of Italy’s debt.  The entire eurozone has a GDP of around 9.5 trillion euros but no one is volunteering to take on debt issued by someone else’s government (again, I use end of 2010 data from Eurostat).

To put the scale further in perspective, compare them with the IMF’s ability to lend to countries in trouble.  The technical term is the fund’s “one year forward commitment capacity” which for “Q3 to date” is 246.0 billion SDRs (September 15 update; SDRs are “Special Drawing Rights”, which exist only at the IMF.)  On September 20, 1 SDR was worth 1.57154 US dollars, so the IMF could lend no more than 386 billion dollars — as one euro is worth about 1.37 US dollars this week, this is about 280 billion euros. 

Or you could think of it as 15 percent of Italy’s outstanding debt.  This is not the only way – and not a precise way – to think about what the IMF could bring to the table, financially speaking.  But it makes the right point; the European issue is way above the IMF’s pay grade. 

Germany, France, Italy and their colleagues need to sort out how to bring the situation under control – to decide who will definitely pay all their debts and who needs some kind of restructuring.  About a quarter of the world’s economy therefore remains in limbo, beset by repeated waves of uncertainty.  And financial market fear can spread to other places, including the United States.

Complaints may be heard this weekend, but there is no one at the IMF meetings who can persuade the key European players to move faster in their decision-making.  The politicians will take their own time – prodded periodically, no doubt, by the financial markets. 

Do not expect a fast resolution or, therefore, a quick turnaround in the global economy.

An earlier version of this column appeared on the NYT.com Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

After receiving US support at the critical moment, Christine Lagarde was named Tuesday as the next managing director of the International Monetary Fund.  In campaigning for the job, Ms. Lagarde – the French finance minister – made various promises to emerging markets with regard to improving their relationships with the IMF.  But such promises count for little and the main impact of her appointment will be to encourage countries such as South Korea, Brazil, India, and Russia to back away from the IMF and to further “self-insure” by accumulating larger stockpiles of foreign exchange reserves – the strategy that has been followed by China for most of the past decade.

Seen from an individual country perspective, having large amounts of dollar reserves held by your central bank or in a so-called sovereign wealth fund makes a great deal of sense; this is a rainy day fund in a global economy prone to serious financial floods.  But from the perspective of the global economy, such actions represent a major risk going forward – because it will further push down US interest rates, feed a renewed build up in private sector dollar-denominated debt, and make it even harder to get policymakers focused on a genuine fix to our long-term budget problems.

Ms. Lagarde is a sincere person and will no doubt try to be friendly to her supporters, for example perhaps by creating a new senior management level job at the IMF and making sure this goes to China or another emerging market.  But what the emerging markets really want is more “quota” (the term used for share ownership and therefore votes at the IMF), as well as more seats on the fund’s executive board.  These are not within Ms. Lagarde’s purview to grant – rather the European Union, at the highest political level, would have to agree to give up some of its votes and reduce its voice.

The European Union is overrepresented at the IMF, both in terms of shares and – most egregiously – with 8 or so seats on a board of 24 members (the exact seat count depends on how you score some seats that are shared by Europeans and non-Europeans).  But the EU has just proved to itself and to everyone else that it both cares a great deal about who controls the IMF and that it can continue to assert this control.

To be fair, the control this time was partly about organizing early and unanimous support for Ms. Lagarde – and there was an understandable desire to appoint a woman, given recent events.  But partly EU predominance in this forum continues to be about disorganization among the emerging markets; countries which, despite the widely used collective moniker, do not really see themselves as having convergent interests either now or in the near future.

If you look at these events from the perspective of countries such as South Korea, India, South Africa, Brazil, or Russia, what conclusion would you draw?

Emerging markets cannot rely on the IMF to provide help on generous terms during a crisis – such support looks like it is available to European countries but not to others.  As a result, an appropriately cautious strategy is to hold a great deal of reserves – the only form of unconditional “foreign” support in a serious financial crisis comes from your own hard currency, perhaps in the form of US Treasury securities that can easily be sold in a liquid market.

What else constitute appealing foreign exchange reserves in today’s world?  The euro has some use, but this is limited as long as a serious sovereign debt crisis looms – very few eurozone governments now look to be “risk-free”.  The Swiss franc continues to do well, but this is a relatively small volume of available assets.  The British pound and the Japanese yen have lost a lot of their traditional allure as reserve currencies.

This leaves the US dollar which, despite all our obvious problems, is still the world’s number one reserve currency.  Emerging markets are likely to increasingly follow in the footsteps of China – attempt to run current account surpluses, intervene to prevent their currencies from appreciating (selling local currency and buying dollars), and invest the proceeds in US dollar assets.

If our fiscal and financial house were in order, the resulting inflow of foreign capital would constitute a bonanza – allowing us to invest productively while paying low interest rates.  But given the way our financial system operates and the dysfunctional nature of our budget politics, the availability of this capital will just encourage us further to overborrow, both in the private sector and in the public sector.

An edited version of this column appeared this morning on the NYT’s Economix blog; it is used here with permission.  If you would like to reproduce the entire blog post, please contact the New York Times.

Just a few years ago, eurozone countries were at the forefront of those saying that the International Monetary Fund had lost its relevance and should be downsized.  The organization was regarded by the French authorities as so marginal that President Nicolas Sarkozy was happy to put forward the name of a potential rival, Dominique Strauss-Kahn, to become managing director in fall 2007.

Today the French government is working overtime to make sure that a Sarkozy loyalist and the leader of his economic team – Finance Minister Christine Lagarde – becomes the next managing director.  Why do they and other eurozone countries now care so much about who runs the IMF?

The euro currency union has a serious problem, to be sure, with the likes of Greece, Ireland, and Portugal, but it is beyond bizarre that these countries now find themselves borrowing from the IMF.  The IMF typically lends hard currency to countries that have “balance of payments” crises – meaning that they have been importing more than they were exporting, and the previous private sector capital inflows (typically loans of some kind) that financed this current account deficit have now dried up. 

Greece has a current account deficit but its money, the euro, is one of the world’s hardest currency – it is a “reserve currency” meaning that central banks and private business keep their rainy day funds in euros (as well as dollars, yen, Swiss francs, and perhaps still British pounds.)  The eurozone as a whole does not have a current account deficit. 

I recall vividly discussions with eurozone authorities in 2007 – when I was chief economist at the IMF – in which they argued that current account imbalances within the eurozone had no meaning and were definitely not the business of the IMF.  Their argument was that the IMF was not concerned with payments imbalances between US states (all using the dollar), and we should likewise back away from discussing the fact that some eurozone countries, like Germany and the Netherlands, had large surpluses on their current account while others, like Greece and Spain, had big deficits.

Those eurozone treasury and central bank officials had a point.  After all, if one of the deficit countries got into trouble, it could be helped out by other members of the currency union.  As the euro is a reserve currency – and a highly regarded one, for example it remains strong relative to the dollar – the IMF is essentially now lending euros to the eurozone in its various bailout programs.

Why does this make sense?

It doesn’t – unless you understand that the goal of these various bailouts is to ensure that German and French taxpayers do not realize the full extent of their losses or the ways in which their banks have been completely mismanaged.

Take the most generous interpretation of IMF lending to Greece – it is like the U.S. Troubled Asset Relief Program, in the sense that there will be a great deal of outlay but all or most will be repaid in nominal terms.

Such lending could be made just as easily by other eurozone countries, either from current resources or by borrowing in the markets – for example, Germany has plenty of fiscal credibility and issues some of the lowest risk sovereign debt available.  But even if the money lent to Greece in this fashion were all paid back, this would look bad – to German voters (and to French voters, as France would have to lend also).

Such loans are much more risky than commonly supposed.  The IMF does eventually get its money back nominally, but not always in real terms (adjusted for inflation) and definitely not on a risk-adjusted basis (i.e., the interest rate charged does not include proper compensation for the risks being taken).  There is a very real possibility that some or all of the monies lent will not be paid back in the foreseeable future.

The International Monetary Fund is, in this regard, essentially a credit union owned by 187 countries – with voting based on ownership shares that reflect relative economic size.  The European Union “owns” about 30 percent of IMF, so 70 percent of any money at risk belongs to other countries: about 17 percent US, 7 percent Japan, 35 percent emerging markets, plus some more mixed sets of countries.

The managing director of the IMF is the impresario of any bailout.  The big decisions must be negotiated with all significant stakeholders but this still leaves enormous scope for discretion.

If Ms. Lagarde becomes managing director she can directly influence the terms of IMF involvement – and based on her negotiating position to date within the eurozone, we can presume she will lean towards more money, easier terms, and above all no losses for the banks that made foolish loans.

Increasingly it looks like the eurozone leadership, under French guidance, will go for the Full Bailout option, in which all Greek debt is bought up by the IMF, by the European Central Bank, and by other eurozone entities.  This debt will be held to maturity – and any creditor who did not yet sell will be made whole (those who already sold at a loss are out of luck).

This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal.  The IMF may need to raise more capital or – more likely – tap its credit lines from member governments.

To be clear, the Full Bailout is still painful for the debtor countries – their fiscal adjustments will involve spending cuts, tax increases and asset sales.  But the motivation is not generosity.

The Europeans greatly fear their own “Lehman moment” – in which any attempt to impose even moderate losses on creditors will cause chaos throughout the financial system.  The French and Germans fought hard against increasing capital requirements under Basel III and the results of various European banking “stress tests” have been completely noncredible – particularly as they did not take into account serious sovereign debt default scenarios.

The French want to sway decision-making at the IMF in order to use US, Japanese, and poorer countries’ money to conceal from their own electorate that the eurozone structure has led all its members into serious fiscal jeopardy – some borrowed heavily, while others let their banks lend irresponsibly and thus created a large contingent liability. 

The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency.  There is a lot at stake for eurozone politicians.  Ms. Lagarde will run the IMF.

An edited version of this post appeared yesterday on the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

Ms. Christine Lagarde, French finance minister, is the nominee of the European Union for the recently vacant position of managing director at the International Monetary Fund.  The EU has just over 30 percent of the votes in this quasi-election; the US has another 16.8 percent and seems willing to keep a European at the fund if an American can remain head of the World Bank.  It should be easy for Ms. Lagarde to now travel round the world engaging in some old-fashioned horse trading, along the lines of: Support me now, and I or the French government will get you something suitable in return, either at the IMF or elsewhere.

The contest to run the IMF seems over before it has even really begun.  But Ms. Lagarde has a serious problem that may still derail her candidacy, if there is ever any substantive, open, or transparent discussion of her merits.  There is major design flaw in the eurozone and Ms. Lagarde is the last person that non-European governments should want to put in charge of helping sort that out.

Ms. Lagarde is explicitly being put forward as someone who can represent the interests of the eurozone – at a time when the eurozone needs help.  And it really is the eurozone as a whole – including France – that needs help, not just a couple of errant countries (Greece, Ireland, Portugal, and whoever might be next in line for market fears about its government debt and growth prospects).

The founding assumption for the eurozone in 1999, which became a myth during the early 2000s, is that eurozone countries would converge in terms of productivity levels – to put it starkly, Greece would become very much like Germany.  In that view of Europe, it did not much matter if some countries within the eurozone ran current account surpluses while others ran large deficits. 

The deficit countries could finance themselves with loans from the surplus countries, the reasoning went, because they would use the money for productive investments and economic growth would allow them to keep their debt levels relative to GDP under control.

None of this happened.  The productivity gains were seen more in Germany and some other North European countries; unit labor costs, reflecting the net effect of productivity gains and real wage increases, rose sharply in Mediterranean Europe.  And French, German and other “core” banks facilitated this divergence with a surge in lending to both consumers and governments in the periphery – convincing themselves, shareholders, and regulators that this was low risk.

Most of this is not Ms. Lagarde’s fault, of course, as she only became French finance minister in 2007 – although she certainly played a leading role in denying Europe had any serious issues as the global financial crisis began to brew in 2007 and early 2008.  But the bigger issue that more recently she and the French authorities in general have been at the forefront of efforts to deny there is any deep problem and to resist a systematic solution.

France worked long and hard to prevent increases in bank capital during the recently concluded Basel III negotiations.  Bank capital is a buffer against losses; as long as this remains as low as the French government wants, there is no safe way for any eurozone country to restructure its debts.  Low bank capital creates serious systemic financial risk for Europe and the world.

Relatedly, Ms. Lagarde has led the “no restructuring” school of thought in recent months with regard to Greece – and presumably other eurozone countries also.  Debt restructuring is no kind of panacea.  But to take the option completely off the table is also not smart – unless you really think there is no deeper issue that must be addressed.

The eurozone in its first iteration has failed to operate as intended.  Unless you think Greece can now experience a miraculous productivity transformation, the eurozone leadership needs to make a choice.  Do they integrate more, including with generous fiscal transfers to poorer, less dynamic member countries, where people do not like to pay taxes; or do they ease some countries out of the integrated financial system, creating two tiers of participation in the euro currency area – in which some eurozone countries cannot borrow from the European Central Bank?

Either way, the International Monetary Fund can potentially help with loans and with technical advice.  But such money belongs to the international community – there are 187 member countries after all.

And it would need to be a lot of money.  If Ms. Lagarde becomes head of the IMF, she will most likely continue to throw loans at the eurozone problems – if there are even preventive programs for Spain, Italy, or Belgium, the IMF will need to tap its shareholders for at least another $1 trillion in credit lines.

Ms. Lagarde personifies the strategy of gambling for eurozone resurrection with other people’s money.  Why would taxpayers in US and elsewhere want to support her on this basis?

An edited version of this post appeared this morning on the NYT.com’s Economix; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

Greece has no good options. Without question, Greece brought debt problems on itself – this is the consequence of politicians using irresponsible fiscal policy to win elections.

As the International Monetary Fund put it when Greece became the first eurozone country to borrow from the fund in May 2010, “Even with the lower deficits envisaged under the program, the debt as share of GDP will continue to peak at almost 150 percent of GDP in 2013 before declining thereafter.” The situation has not improved in recent months – even under the most optimistic scenario, the debt-GDP ratio will peak above this number.

The problem is that loose talk among European leadership of potentially “restructuring” or “reprofiling” Greek debt creates more problems than it solves. Financial markets fear another Lehman moment, in which authorities decide to let a significant borrower fail – without fully understanding the consequences.

Who in the private sector or the various responsible governments or at the IMF can tell you exactly what would happen – and to whom and where – if Greece were to default in any fashion?

European banks have very low levels of capital, meaning they are highly leveraged – having a great deal of debt relative to their equity. They are not in a position to withstand losses on their large portfolios of European government securities if, as seems likely, Greek problems cause a fall in the market price of Spanish, Italian, Belgian, or other eurozone sovereign debt.

The banks convinced themselves – and their regulators – that lending to all these governments was “riskless”. This was the structural mistake at the heart of the eurozone. Greece and others were able to borrow so much relative to their economies because creditors believed this debt was very nearly just as safe as German Bunds.

European politicians are now choosing between what they see as three options (a) restructure Greek debt, take big losses at French, German and other banks, and deal with the systemic consequences on the fly, (b) provide additional financing to Greece, allowing them to run for another five years without having to come back to the private markets, (c) muddle through, with various promises of further fiscal adjustment, quick privatization, and greater structural reform from the Greek side, while really just hoping that a sufficiently strong global growth boom will lift all ships.

The right approach would be to deal with all troubled eurozone sovereigns and global vulnerable banks in the same pan-European package of debt restructuring where appropriate, fiscal adjustments as needed, and improvements in competitiveness for all countries that have consistently been running current account deficits.

But there is a nearly zero probability for this course of action. European politicians understand the issues just fine, but they do not want to face the electoral consequences that would follow from acknowledging the currency union was poorly designed and implemented.

An edited version of this post appears on the NYT.com’s Room for Debate: Is there any hope for Greece’s debt problem?  See that page for alternative views of what Greece could or should do.

Even before the shocking events of the past few days, the international policy community had been contemplating a successor to Dominique Strauss-Kahn at the International Monetary Fund.

Strauss-Kahn, the IMF managing director, was expected to begin campaigning soon for the presidency of France. Now, whatever happens in the New York legal system as he defends himself against attempted rape allegations, it seems likely that the IMF will be searching for a new head sooner rather than later.

To read the rest of this column, please follow this link: http://www.bloomberg.com/news/2011-05-17/emerging-markets-might-name-strauss-kahn-heir-simon-johnson.html

The EU, led by France and Germany, appears to have some sort of financing package in the works for Greece (probably still without a major role for the IMF).  But the main goal seems to be to buy time – hoping for better global outcomes – rather than dealing with the issues at any more fundamental level.

Greece needs 30-35bn euros to cover its funding needs for the rest of this year.  But under their current fiscal plan, we are looking at something like 60bn euros in refinancing per year over the next several years – taking their debt level to 150 percent of GDP; hardly a sustainable medium-term fiscal framework.

A fully credible package would need around 200bn euros, to cover three years.  But the moral hazard involved in such a deal would be immense – there is no way the German government can sell that to voters (or find that much money through an off-government balance sheet operation).

Alternatively, of course, the Greeks could make much more dramatic cuts to their primary deficit – the government budget balance if you take out interest payments – in order to stabilize their debt-GDP ratio.

But with no significant resurgence of growth in the eurozone coming for a long time, that would really mean moving from last year’s 7.7% GDP primary deficit  to around a 6% GDP primary surplus (assuming they face a real interest rate of 5%, i.e., below what they are paying today).

The government won’t (or can’t?) do that.  In 2009 Greek wages and pensions rose by 10.5% – an amazing spending spree.  In the 2010 budget they are forecast to rise by 0.3%.  Where is the austerity?  No wonder the prime minister is popular – they aren’t really cutting much.

The bailout package is really just an opportunity for European banks to get out of Greek debt.  The Greeks can’t really collapse until they lose access to funding, so the hope is that this prevents the problems from spreading – and the prospects of such a “rescue” will keep bond yields down for Portugal, Spain, and others. 

Our baseline view is that Greece enters into quite a bad recession this year, their banks and corporates continue to have trouble raising financing – thus causing broader liquidity issues, and it all comes to a head again as we near the time the government needs to take ever harsher measures next year, when there is again no bilateral funding in place.

This is the new Greek cycle.

European Union pressure is growing for Greece to “do the right thing” – which means, to the EU’s leaders, a massive and sudden cut in the Greek budget deficit.  Greece, without doubt, has gotten itself into a fine mess; still, it is now time for the Greek government push back more effectively.

Fuming at EU arrogance will accomplish nothing.  And, while global investment banks may have helped hide the evidence, it seems unlikely they actually designed the great blunder of eurozone admission (and broken Greek promises).  It’s time to stop blaming others and get crafty.

Greece should open a semi-official channel to the IMF and talk discretely about taking out a loan.

This is not an anti-Greek suggestion.  The IMF has changed a great deal over the past 10 years – learning lessons and developing new ways of thinking.  (For more detail, see my current Project Syndicate column.)  Today’s IMF would give Greece a much more reasonable deal than would the EU acting alone.

But the main reason to approach the IMF is that this, if done properly, would drive the EU nuts in a most productive manner.

The Germans really do not want more IMF pressure to ease up on European Central Bank monetary policy or – heaven forbid - to engage in some fiscal expansion (or other increase in domestic demand).  The Germans want to export their way out of recession, and the devil take the hindmost.

And President Sarkozy absolutely does not want the current IMF Managing Director - Dominique Strauss-Kahn - to do anything that can be presented as a statesman-like contribution to the world.  Strauss-Kahn is a contender for the French presidential election in 2012, so you can see how that works.  (Aside: strictly speaking, according to IMF rules, Strauss-Kahn should step down from the Fund; but he is too wily a politician to let anyone push him out at this moment.)

By approaching the IMF, Greece will get a better deal from the European Union.  Our baseline view is still that the IMF’s role will be only “technical”, but behind the scenes the prospect of greater IMF engagement (and even a standby loan) is a powerful card that Greece should threaten to play.

For one perspective, the Carnegie Endowment for International Peace had a session at the end of April featuring a few IMF economists. Marco Terrones (link to PowerPoint at the bottom of the page) looked at the typical duration of a recession and the ensuing recovery. The duration of recovery is measured to the point at which the economy reaches its previous peak output (the output level when the recession began – December 2007 in our case). He looked at 122 recessions since 1960. 

Terrones’s key point was that recessions last longer, and take longer to recover from, if they are linked to financial crises or if they are globally synchronized, for reasons that are probably evident to our readers: popping credit bubbles lead to an increase in the savings rate, dampening consumption; and globally synchronized recessions mean that no country can export its way back to growth. On average (slide 5), a recession that is both linked to a financial crisis and globally synchronized will last three quarters longer than normal (seven rather than four), and recovery, measured from the beginning of the recession, will take seven quarters longer than normal (fourteen rather than seven). (There is obviously some correlation there, since the longer the recession, the more ground needs to be made up.)  Those are just averages, but projecting onto our experience that means recovery would start in Q4 2009, but we would not reach our peak (December 2007) output level until late 2011. Since the workforce will have grown by a few percent in the interim, unemployment would not reach December 2007 levels – if ever – for another year or two. 

Seven quarters of contraction and seven of recovery to previous peak don’t seem that bad. Of course, this is still just an estimate based on data going back to 1960, and there is nothing in that time period like what the world is going through today.

This analysis is covered in greater detail in Chapter 3 of the IMF’s April World Economic Outlook.

By James Kwak

Today, the Congressional Budget Office is pointing out that it would be premature to congratulate ourselves too much (disclosure: I’ve joined the CBO’s Panel of Economic Advisers, but none of the information here comes from them).  As you likely know, the administration is proposing to lend $100bn to the IMF, as part of that organization’s increase in resources following the G20 summit.  Peter Orszag, head of OMB, argued that there was zero probability of this money being lost, so $100bn should be “scored” for budget purposes as $0bn – which is how this kind of transaction has been handled in the past.  As the IMF likes to say, it is “the lender of last resort, but the first to be repaid.”

After considerable back and forth, the scoring issue was refered to the CBO.  The CBO has reportedly decided there is a 5 percent probability of default by the IMF.  This is an extraordinarily important statement.  Most informed people just assume that the risk of IMF default is zero, because that would essentially constitute a complete breakdown of the global economy and payments system.  But nothing is zero probability, particularly in a world of massive financial panics, incipient protectionism, and improvised global governance.

We can discuss if 5 percent is too high or too low; the CBO details are not out yet, so it’s hard to know exactly the time scale they are thinking about – my guess is 5 years.  In any case, this estimate tells you that – even with the increase in IMF resources to close to $1trn, which will go through if the US approves this $100bn loan – the CBO thinks (a) the crisis is not over, and (b) there is a nonzero probability that the entire global system breaks down.  Take this seriously.

Our point yesterday was: don’t throw another fiscal stimulus into the mix at this point, even the IMF – which has become a strong advocate of discretionary fiscal policy under some circumstances – is saying that it will not speed the recovery much.  Save the fiscal space for further stimulus for when you might really need it, i.e., the unlikely, but possible, confluence of circumstances that would constitute another serious panic phase.

By Simon Johnson

The committee was mostly in favor of the US continuing to play a leading role in supporting the IMF, but pressed the witnesses to explain whether the IMF could lose this money (highly unlikely), how this would protect American jobs (definitely, but hard to quantify precisely), and if the broader package of IMF reform should also be supported (e.g., the proposed gold sales are being reassessed, to see they could generate more resources for aid to developing countries).

Politico is reporting that US funding for the IMF is likely to be attached to the war supplemental spending bill.  The subcommittee’s chairman, Gregory Meeks, seemed positive – as did all the Democrats who spoke, along with Gary Miller, the Ranking Member/Senior Republican.  But, based on remarks made by at least two Republican members of the subcommittee, there is likely to be a big public fight at some point.  My guess is that the Democratic side will press hard for President Obama to more publicly explain why supporting the IMF (and the G20) is very much in the US interest.

The main points from my written testimony are below.  While Treasury represents the US vis-a-vis the IMF and traditionally has considerable scope for action, the views of Congress on IMF details are very important as both guidance and constraints.  In our advice on the wide range of IMF-related issues below, both I and the other witnesses laid out broadly similar views with varying emphasis – there was actually much more disagreement among committee members than at the witness table.

Main points

Low income countries have been severely affected by the global economic downturn.  Many of the worst consequences, including on the poorest people, have yet to be felt.

In that context, by contributing to the stabilization of the world’s financial system, the G-20 summit had a positive effect.  However, it left open a large number of important issues, some of which call for immediate congressional attention.

First and foremost, low income countries need to receive considerable additional resources in order to weather the crisis.  This crisis is not of their making and, prior to this shock, poorer countries were making considerable progress along the lines of implementing exactly the policies advised by richer countries and the International Monetary Fund (IMF).

The IMF has adapted its standard forms of conditionality to current circumstances.  The goal of protecting core social spending is commendable and long overdue, and the implementation in recent East European and Pakistan programs is encouraging.  However, the retreat from structural conditionality has probably gone too far and needs to be reappraised; the weaknesses of low income countries arise from and are manifest in disproportionate power of key individuals or sectors, and this needs to be addressed in a transparent manner wherever the IMF is engaged.  In situations where such issues have been taken on board – as with transparency for extractive industries – the reception among civil society has been very positive.

The potential US legislative package (including IMF gold sales, its new income model, and $100 billion for the New Arrangements to Borrow) is worth serious consideration but also needs careful congressional review.  The $250bn issue of Special Drawing Rights is a bold move which, while it involves some risks, is well worth taking – hopefully, this will be regarded as a pilot project for potentially larger increases in resources for troubled countries, on an “as needed” basis.

The G20 called for $6 billion of additional concessional resources from the Fund over the next 2-3 years for Low Income Countries, including some vague phrasing on money from gold sales. So far, the gold piece of this puzzle remains stalled at the level of the IMF’s executive board.  More transparency around board discussions on this and other items would reveal who is holding up change and for what reason.

Providing additional resources to low income is a very good idea, and increasing the resource flow from and through the IMF is timely and appropriate.  If these resources can come from “extra” proceeds from gold sales, that would be an attractive solution – particularly as the income model needs some adjustment in the light of (a) the increase in Fund lending over the past 12 months, and (b) the introduction of the Flexible Credit Line, which offers the promise of Fund revenue even during quiet times for the global economy.  However, it is too early to determine how profoundly the Fund’s income model will be affected by this crisis and how the world responds.

As long as the Fund lends at concessional rates to low income countries (and the relevant, Poverty Reduction and Growth Facility interest rate is only 0.5% per year currently), loans may be attractive relative to grants – the key issue is the resource flow that is available, i.e., does lending allow more transfers in a meaningful and sustainable manner.  Avoiding unsustainable debt burdens is of course of paramount importance.

Most important, we should take all available actions to shore up low income country defenses against this crisis.  We should also guard against any form of complacency.

For that reason, it is most important that the IMF be authorized to restore its budget to its early 2008 level (i.e., before the 15-20% across the board cuts were implemented).  Cutting the budget and letting go some of the most experienced IMF staff was the unfortunate result of gross macroeconomic negligence at the level of leading industrialized countries, including the US and its G7 partners.  At the same time as the IMF was warning, clearly and firmly, that a global crisis was developing, major shareholders pushed through budget cuts that resulted in some of the IMF’s best people leaving the organization.

Undoing the budget cuts would be embarrassing to leading European countries, but it should fine support from the Obama Administration – after all, it was their idea to make increasing IMF resources a central issue at the recent G20 summit.  The IMF simply does not currently have sufficient skilled staff to undertake all the important tasks it has been asked to handle.

The G20 summit effectively agreed to end the European monopoly on the position of Managing Director at the IMF.  Since the summit, there has been some indication of backsliding on this issue, but assuming that European countries can be kept to their commitments, this would be a major step in the right direction.  Given that the next leadership change is likely to take place in a little over a year, identifying and supporting sensible candidates from emerging markets would be most constructive.  If an Indian or a Brazilian, for example, could be brought in as Managing Director, that has the potential to greatly expedite the rebuilding of the IMF’s legitimacy and its engagement throughout the developing world.

Unfortunately, IMF credibility has been somewhat damaged by its inability to follow through on exchange rate surveillance, particularly with regard to China.  While there seems to be a movement towards implicit agreement among leading countries, in and around the G20, to take this issue of the table, that would be a serious mistake.  Countries must not think that competitive devaluation (or even sustaining accidental undervaluation) is a sensible or attractive policy.  This will lead to greater global imbalances and potential instability, as some countries compete to get current account surpluses and other countries – willingly or not – run deficits.

Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves.  This creates problems for reserve currency countries (e.g., the United States) as well as for the global system as a whole.  We need an international system that can handle these issues and prevent them from becoming destabilizing.  The IMF should be given another chance to show that it can help run the global system in a constructive fashion.  This is of paramount importance for the United States and for everyone who wants to participate in an open international trading system – particularly low income countries, which have few other opportunities to grow and which remain highly vulnerable to shocks of all kinds.

By Simon Johnson

To that end, we’re developing on-line polls in which you can register your views on questions that are currently being debated – either in general terms or as specific legislation – on the Hill (of course, longer comments are also welcome; it’s a blog, after all).  Today’s question is about whether the United States should provide an additional $100bn to the IMF, as was agreed at and immediately after the recent G20 summit; this is for a hearing held by a subcommittee of House Financial Services, which starts at 10am.

We’ve argued consistently that supporting the IMF can play an important role in stabilizing the global economy, and the Obama Administration handled this aspect of the G20 summit well.  But have they made the case for why this is important, how the IMF will change, and what could happen if the recapitalize-the-IMF ball is dropped?  Do you really believe the Europeans will follow through on their promise not to press for (yet) another European as the next Managing Director of the IMF (and there are some signs of backsliding on this issue)?  Without that, can the IMF fully rebuild its legitimacy?

Does the money for the IMF feel like essential stabilization or a bailout for countries that shouldn’t be bailed out?  What would it take to persuade you to support the Administration on this point?  Post your comments here or at The Hearing, but the poll is only at The Hearing.

By Simon Johnson

It is of course sensible to use fiscal stimulus to offset a fall in private demand, and to some extent this can be effective – with a lag.  But if you lose control over public spending and borrow too heavily (helped by the fact people like to hold your currency), it ends badly.

From the beginning, we’ve expressed concern here that the entire Summers Plan was overweight fiscal, i.e., not enough resources for recapitalizing banks and addressing housing directly (for the context of this assessment, see our full baseline view).  Back in December/January, this was a strategic choice worth arguing about; now it’s a done deal and following the (very) limited recapitalization outcome of the bank stress tests, it seems likely that household and firm spending will remain sluggish.  If that is the case, the Administration’s logic implies throwing another big fiscal stimulus into the mix – and the Summers’ team is already preparing the groundwork.

The IMF is now warning against the risks of this approach, albeit using carefully worded language.

In a 20 minute presentation at the Carnegie Endowment on April 30th, Olivier Blanchard made statements that are striking coming from the IMF’s chief economist (webcast; slides; fan chart for growth forecast).

Remember that the IMF is the custodian of the official consensus on the global macroeconomy and financial system – so if their baseline view is in the same ballpark as your stress test results, the IMF is telling you to be more pessimistic.  They can nudge a powerful government, like the US, in a particular direction – but not too hard in public on a politically sensitive issue such as fiscal sustainability (or lack of capital in the banking system).

Blanchard is clear that the IMF sees the need to “fix the financial system”.  He also assumes this will happen slowly, and indicates this slowness is not helpful for the recovery.  The implication is that the US will resort to even more fiscal stimulus if the recovery proves sluggish – look at his slide on p.7, dealing with fiscal sustainability (this is discussed at about minute 11 in the webcast).  This presentation of country averages is an IMF way of talking about difficult country-specific situations without being indelicate  – and the point here is to push you to think about the nonconvergent (red…) debt path with contingent liabilities (i.e., what the government is committing to the banking system without acknowledging the fact); the yellow path for debt, with slow economic growth, also does not look good.

Blanchard doesn’t show the US debt forecast – presumably that would be indelicate.  But at the 13:13 mark, he warns that the US may be heading in the same fiscal direction as Ireland (!), “the [US budget] numbers are not great but we hope that something will be done.”  

The content and timing of that  ”something” is left vague – add your suggestions below.

By Simon Johnson

At the exact same time that we were writing that article, Desmond Lachman – who worked at the IMF for 24 years, and then worked on emerging markets for Salomon Smith Barney for another seven years – was writing an article for the Washington Post saying many of the same things.* Here are the first three paragraphs:

Back in the spring of 1998, when Boris Yeltsin was still at Russia’s helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to “emerging markets” throughout Asia, Eastern Europe and Latin America, and I thought I’d seen it all. Yet I still recall the shock I felt at a meeting in Russia’s dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia’s economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia’s economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I’m hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a “lost decade” after its own real estate market fell apart in the early 1990s. But I’m more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we’re trying to fix it.

Over the past year, I’ve been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking — with other people’s money — for their personal gain.

And here’s the conclusion:

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to “get their house in order” — without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Enjoy.

* For the record, the Atlantic article was finalized on March 17 and went up on the web on March 26; judging from the URL, it looks like Lachman’s article went up on March 25.

In this clip, Mandelson comes on around the 12:48 mark (after Peer Steinbruck, the German finance minister, provides some complacent sound bites.)

But the surprising statement comes after the short interview with me (I start at 17:40 approx; Mandelson comes back around 21:38).  I have no idea if Mandelson knew this could happen, but Jon Snow (the anchor) goes back to him and asks if he agrees with me that the UK could borrow from the IMF.

The conventional answer, of course, would be something like “under no circumstances.”  Instead, Mandelson says the UK won’t be “at the top of the queue” for going to the IMF.  Even when pressed, he laughs but refuses to categorically rule out that the UK might need to borrow from the Fund.

And he also clearly articulates the broader G20 strategy vis-a-vis the IMF: destigmatize borrowing.  And what could be more helpful, in that regard, than countries such as the UK borrowing when they need assistance (think banking, budget deficit, current account deficit) but before they approach a traditional full-blown crisis situation?

By Simon Johnson